The Multinational Monitor

 

September 2002 - VOLUME 23 - NUMBER 9


T H E    F R O N T

Environmental Liabilities

While the U.S. Congress tries to unravel the Enron accounting scandal involving hundreds of millions of dollars of debt hidden illegally from shareholders, a U.S. federal agency charges that many publicly traded corporations hide billions of dollars in environmental liabilities.

The U.S. Environmental Protection Agency (EPA) has disclosed that 74 percent of U.S. publicly traded corporations it surveyed violate the U.S. Securities and Exchange Commission's (SEC) environmental financial debt accounting regulations.

The findings are based on a 1998 EPA study of corporate compliance with the SEC's Regulation S-K, mandating that all publicly traded companies provide quarterly and annual financial reporting of significant corporate environmental liability and debt exposure related to violation of U.S. environmental laws.

The hiding of corporate environmental liability from shareholders is a significant issue in the stock market. Corporate exposure to environmental financial costs involving compliance, cleanup and legal fees is estimated by the insurance underwriting industry at over $100 billion.

Officials at the EPA say the high percentage of publicly traded corporations hiding their environmental debt from shareholders and the lack of enforcement by the SEC of its environmental accounting filing regulation is rewarding corporate noncompliance to U.S. environmental laws.

"This departure from SEC-mandated disclosure puts good companies at a disadvantage in the absence of reporting EPA legal proceedings," says Shirin Venus, attorney for the EPA's Office of Planning, Policy, Analysis and Communications. "Enforcement would give assurance that disclosures are being made correctly, and provide incentives for better performance."

In January 2001, the EPA Office of Planning, Policy Analysis and Communications and Office of Regulatory Enforcement directors sent the SEC's Division of Corporation Finance and Division of Enforcement directors notice of the EPA's national effort to promote environmental SEC disclosure, with references to the agency's 1998 study.

It is the SEC's job to administer and enforce the federal securities laws of the United States in order to protect investors and to maintain fair, honest and efficient markets. But in the last 20 years the SEC has enforced Regulation S-K only once.

SEC Regulation S-K mandates disclosure of:

  • all environmental proceedings, including governmental proceedings, which are material to the business or financial condition of the registrant;
  • damage actions, or governmental proceedings involving potential fines, capital expenditures or other charges, in which the amount involved exceeds 10 percent of current assets;
  • governmental proceedings, unless the registrant reasonably believes such proceedings will result in fines of less than $100,000.

Environmental organizations have criticized these requirements for allowing corporations too much leeway for interpretation of what is financially material when it comes to disclosure of environmental liability and cleanup costs to shareholders.

A coalition of more than 60 organizations is spearheading an effort to have the SEC strictly enforce and improve securities law requiring corporate filing of significant environmental material expenses. The group, called the Corporate Sunshine Working Group, covers the spectrum from money management firm Kinder Lydenberg & Domini to the United Steelworkers of America and Friends of the Earth.

The Corporate Sunshine Working Group argues that the non-disclosure of environmental liabilities and cleanup costs by publicly traded companies makes a real difference in companies' share price ˇ and is thus necessary to protect shareholders, not just the environment. They cite a class action lawsuit filed by shareholders of U.S. Liquids against the firm for concealing material environmental information that resulted in an artificially inflated share price.

"This company claimed that its liquid waste management services, which generated more than 90 percent of the U.S. Liquids revenue, would result in 20 percent earnings per share growth," says Michelle Chan-Fishel, international policy analyst for Friends of the Earth. "Little did investors know that the company was concealing its illegal dumping activities," she says, "and when one of the company's most important facilities was heavily fined and temporarily shut down, share value fell by over 50 percent."

The World Resources Institute (WRI), a not-for-profit organization based in Washington, D.C., released reports in 2000 supporting the contentions of the Corporate Sunshine Working Group. The WRI reports showed pulp and paper companies are not disclosing environmental risks that may significantly affect their financial performance.

"This lack of disclosure infringes Securities and Exchange Commission (SEC) rules and directly threatens investors in pulp and paper companies," said WRI economists Robert Repetto and Duncan Austin in their reports.

Corporations often hide their financial environmental risks from their SEC filings by stating the costs and claims will not have a material adverse effect on operations and financial position. Executives argue that pending litigation can't be qualified and the assessed financial risks are too small to spell out given the company's size. And the U.S. accounting auditing bodies issuing clean financial audit opinions for those firm's SEC filings agree with that stance.

In February 1997, three environmental groups (Friends of the Earth, Sierra Club, and Citizen Action) sent a letter to the SEC, demanding an investigation of the entertainment giant Viacom Inc. for failing to report an alleged $300 million in Superfund cleanup liabilities in its annual report to shareholders. Price Waterhouse LLP, which audited Viacom's annual report, also issued a clean opinion for Viacom's financial report to shareholders minus the questionable Superfund liability figures. Viacom executives claim the EPA and environmental groups were overstating the cleanup costs.

Martin Freedman, professor of accounting at the College of Business and Economics at Towson University in Maryland, believes Viacom's Superfund accounting departure is not unusual. "My 1996 study of the Environmental Protection Agency's list of 900 publicly traded, potentially responsible parties listed on the National Priority List found most companies make little or no disclosure effort on environmental expense/liability reporting," he says, "and it's getting more and more overt."

In 1998, the SEC issued a bulletin for companies to abide more strictly by SEC rules in completely revealing corporate material expenses. The aim of the Commission's bulletin was to stop the practices of some corporations that seek by accounting strategies to cover up financial losses so these losses do not bring down share prices.

Four years after release of the bulletin, SEC officials still maintain a reluctance to review corporate failures to file 10-K form filings detailing significant environmental material expenses.

"The Office of the Chief Accountant has not recently reviewed and is not in a position to comment on the Environmental Protection Agency study," says John M. Morrissey, deputy chief accountant for the SEC. "The Commission's Division of Corporation Finance selectively reviews filings with the Commission for compliance with the SEC's disclosure requirements, including disclosure related to environmental legal proceedings."

Under current federal securities law, "material" information is anything that an average investor ought reasonably to be informed of before buying a security. The definition of environmental materiality as anything affecting air, land, water or public health is considered an old-fashioned definition in many corporations. Instead, many auditors and their business clients today define environmental materiality as any event or news which will affect a company's revenues by a 10 percent threshold level.

The Corporate Sunshine Working Group claims under these reporting conditions shareholders are often left out of the loop of unreported controversies which can ultimately affect the corporate financial position. "Our objective is to have the SEC uniformly enforce their current environmental accounting regulations and create more clarification for existing rules," says Sanford Lewis, an attorney and co-chair of the group.

"Part of the problem with the current SEC regulations is they are just vague enough that corporate counsel can easily provide boilerplate language that eliminates meaningful disclosure of these issues," says Lewis.

"These financial environmental accounting departures affect the EPA's operations," says the EPA's Venus.

"Market mechanisms which require full transparency are undermined by these departures and it sets a disincentive for others to comply if competitors aren't," she says.

ˇ Donald Sutherland

Advertise This!

Corporations are gaining ground fast in their effort to assume all of the U.S. constitutional protections afforded human beings.

Some of the last limitations on corporate free speech rights may be about to fall, thanks to Supreme Court decisions that increasingly equate commercial advertising with political speech, and a Food and Drug Administration (FDA) that appears eager to accept Court-imposed restrictions on its authority.

An 1886 Supreme Court decision established that corporations in the United States are entitled to constitutional protections. Since then, the Court has progressively extended Bill of Rights protections, including First Amendment speech rights, and other constitutional guarantees to corporations. In 1978, the Court established a constitutional right to "commercial speech" ˇ speech intended to promote and advertise products for sale, as opposed to political or expressive speech.

Since 1978, the courts have steadily expanded commercial speech rights [see "First Amendment Follies: Expanding Corporate Speech Rights," Multinational Monitor, May 1998], taking a potentially dramatic step in a decision issued earlier this year.

In that decision, Thompson v. Western States Medical Center, the Supreme Court interpreted its commercial speech test, developed in a case called Central Hudson, to make it very difficult for the government to restrict commercial speech.

Western States Medical Center involved a provision of a 1997 law that permits pharmacies to make compounded pharmaceuticals ˇ drugs manufactured on the premises, to serve the specific needs of particular patients. The 1997 law permits compounded drugs to be sold ˇ even though they have not passed FDA safety and efficacy tests ˇ but on condition that they not be advertised. The basic idea is to seek a balance: to permit manufacture for specifically prescribed needs, but to prevent pharmacies from circumventing the FDA's safety rules by advertising untested compounded drugs to the broad public.

The Supreme Court struck down this provision, holding that it violated the commercial speech rights of the pharmacies. In conducting the Central Hudson test, the Court agreed that there is a substantial governmental interest in protecting public health and preserving the integrity of the FDA drug approval process, and conceded the advertising restrictions might directly advance these ends. But it held that the law failed to satisfy the final prong of the Central Hudson test, "whether it is not more extensive than necessary to serve that interest."

Justice O'Connor, writing for the majority, posited a series of alternatives to an ad ban, without citing any evidence, or even providing compelling arguments, that these alternatives would work as effectively as an ad ban. But they were enough for the majority to conclude that the advertising restrictions were more extensive than necessary.

This holding seems to move the Central Hudson test away from ascertaining whether there is a reasonable fit between the government's commercial speech regulations and its legitimate goals, and towards a much higher level of scrutiny. The Court is beginning to break down the constitutional distinction between political and (nonmisleading) commercial speech ˇ even though commercial speech protections essentially apply uniquely to corporations, which do most commercial advertising.

The Supreme Court justifies this rising level of protection for commercial speech on the grounds that the government cannot legitimately deny the public truthful commercial information to prevent the public from making bad decisions with the information.

The high level of protection afforded to commercial speech by the courts poses a difficult challenge for regulatory agencies that seek to restrict advertising, including and especially the FDA.

For example, drug companies now spend billions of dollars a year on Direct-to-Consumer (DTC) prescription drug advertising, with more spent to advertise leading drug brands than Pepsi or Budweiser. These ads encourage consumers to demand, and doctors to prescribe, pharmaceuticals that people don't need. The ads fail to convey the comparative benefits of the marketed drugs to alternatives. They don't reveal price information.

As long as the Supreme Court holds that there are constitutional speech protections for corporations, it will be nearly impossible to ban DTC ads. Now, the extent of FDA's authority to regulate them is somewhat uncertain.

But, says, Larry Sasich, staff research analyst with Public Citizen's Health Research Group, "government must play an active role in proctoring the information drug and medical device manufacturers provide to physicians and patients because the incentives for manufacturers to distort the Űtruth' by providing the public a misleading, one-sided presentation of the scientific evidence are enormous."

Efforts to regulate tobacco ˇ a product not currently under the jurisdiction of the FDA, or any federal health agency ˇ will face similar difficulties. There is an abundance of studies conclusively showing that advertising increases smoking rates, especially among youth. Commercial speech protections make it impossible to ban tobacco ads. The Court's new formulation may also make even more modest restrictions on tobacco promotion very difficult.

There is no question that the Court has made things hard for the FDA.

But public health advocates worry that the FDA may be quite happy to forfeit the powers it needs to do its job. Under the Bush administration, the agency has operated under the direction of FDA Chief Counsel Daniel Troy, who is a leading advocate for constitutional protections for commercial speech.

In May, the FDA put out a request for comments on issues involving First Amendment protections for commercial speech and the scope of the agency's authority.

The set of questions posed by the FDA has led public health advocates to fear the agency is looking for excuses to throw up its hands ˇ "Sure, we'd like to do our job, but there's not much we can do. The Supreme Court says corporations have a constitutional right to advertise, even if that will harm public health."

A number of organizations have responded by submitting comments and urging the public to do so, as well. Essential Action, a project of Essential Information, the publisher of Multinational Monitor, has posted background information and suggestions for comments at: .

ˇ Robert Weissman